Behavioural Tips: Dealing with the Volatile Investment Markets

November 8, 2022
Scott Kingsley

Since the US subprime mortgage crisis began in 2007, there have been numerous financial challenges for investment markets. We have seen the Covid pandemic, tensions in Ukraine, double-digit inflation and an ongoing cost of living crisis. It is fair to say that this has tested the nerves of many investors. So, how do you cope with volatile investment markets?

The overarching concept of stock market valuations

Before we look at various behavioural tips that might help you deal with volatile investment markets, it is essential to grasp the concept of stock market valuations. While there are varying opinions, the consensus is that stock market valuations today will take into account expectations from between six months and nine months into the future. There will also be unknown factors to consider that could emerge at any time, which may prompt sharp reactions. However, where does the concept of forward valuation leave investors in volatile markets?

If a recession is expected to bottom out in nine months, then there is the chance that markets are already factoring in the worst-case scenario today. Therefore, investors attempting to sell before the worst of the recession may be selling at prices that assume the worst. There is no hard and fast rule regarding the valuation of stock market investments, but there is a consensus.

Behavioural tips to maximise long-term investment returns

The most useful behavioural tip is to remain calm when considering making/not making an investment decision. Whatever is going through your mind, you need to be able to process this calmly and in the cold light of day. There are also many additional behavioural tips that will help you survive in these volatile markets.

Avoid knee-jerk reactions

Have you noticed the headlines on mainstream media websites are either very upbeat or very downbeat? The truth is that mediocre headlines don't sell newspapers and don't attract visitors to your website. So, with this in mind, it is essential not to take notice of the headlines and block out the "noise" traditionally associated with bull and bear markets. Very often, when you dig a little deeper into the articles themselves, they don't always portray what you might expect from the headline.

Don’t panic

As we discussed above, while the news and company headlines today will be specific to what is going on today, markets tend to look further ahead. This is perfectly illustrated when a company comes out with disappointing figures but an upbeat update on trading. Akin to base rates not having an immediate impact on the economy, it will take time for company results to turn around. The key is not to panic; look at up-to-date forecasts for the future and gauge the relative value for money at current levels.

Focus on short-term finances

Even though we have seen the number of day traders increase dramatically in recent years, most investors still invest on a long-term basis. While taking a profit or taking advantage of share price weakness is never wrong, it is essential to appreciate both short-term and long-term finances. What do we mean by this?

It may be that you can afford to save a little more money in the short term. Pay down that credit card or personal loan much quicker than expected. Better mortgage offers may be available, which will give you a degree of stability. Your short-term personal finances will have a more significant impact on your immediate financial, mental and physical well-being compared to your long-term investments.

Accept short-term pain for long-term gain

With the best will in the world, stock markets and individual shares can be incredibly volatile in the short term. You tend to see knee-jerk reactions to a changing outlook for the economy or specific companies. Over time, markets tend to arrive at a "balanced value", but you may have to accept a degree of short-term pain for long-term gain.

For example, if the US NASDAQ market was to wobble, the chances are the majority of global technology stocks will be marked down the next day. This may prompt buyers to come in, or you may see the emergence of more sellers. On the other hand, if the fundamentals for your specific shareholdings have stayed the same, it may be a case of riding out the short-term storm. Consequently, many people will try to sell on the way down, with the idea of buying back at the bottom, making a turn and regaining their exposure. However, if you are optimistic about the stock, why risk a short-term, potentially low-margin trade?

Maintain a healthy mind and body

The brain is a mighty organ that we depend upon every second of every day. This prompts the question, why do many of us not even consider a healthy mind and healthy body might help our investment decisions?

There are numerous issues to take into consideration, such as:-

  • Sleeping patterns 
  • Healthy diet
  • Exercise
  • Socialising

Your mind and body need time to rest, destress and regenerate to get the best out of them. In reality, we all have issues on our minds. These may be financial worries, upcoming events, a planned holiday or positive developments in your social life. Many people believe that sleep is the key to success, the best way to clear your mind, destress your body and make sure you are bright and fighting fit for the new day.

On the flip side, if you struggle to sleep, fail to socialise and ignore exercise and healthy eating, this is not good brain food. If you wake up with a stress level of 7/10 and have a potentially stressful day ahead, you could be living on your nerves. If you wake up with a stress level of 3/10, even a stressful day may not take you higher than a five or six. It is crucial to leave headroom to take account of stress which will help you make the correct investment decisions.

Consider a contrarian investment approach

As human beings, despite many of us having firm opinions on different stocks and investment markets, we tend to act like sheep. Following the herd seems less dangerous and stressful, but what happens if the herd are wrong? You may be drawn into a negative trend where sellers feed the next seller and onwards. This downward spiral can become all-consuming and leave individual stocks and shares oversold. So, what about a contrarian approach?

A contrarian approach works on the way up and the way down and is not focused explicitly on downturns. For example, if investors buy into a company that is beginning to look overvalued, then using a contrarian approach, it may be time to sell or go short. In volatile markets, this tends to be on the downside, where negative sentiment can feed further negative views. A contrarian approach means going against the market, battling the herd and running in a different direction. You might need to be brave and accept your timing may not always be perfect, but the potential rewards of a contrarian investment approach can be significant.

Would you still be a buyer today?

When you strip away the psychology, behavioural traits and challenges of short, medium and long-term investment, ask yourself one question. Would you still be a buyer of the shares (or fund) today if you didn’t already hold them?

This is a simple question you will likely be able to answer within a second. The fundamentals remain relatively unchanged; the stock still has potential in the long term, and market prospects are good. So, if you would still be a buyer today, why are you considering a sale? 

If it’s for a cold, hard, rational reason like in the immediate future you are buying a house, investing in a business, and so on, then that usurps everything. But if fear is driving your action then you’re in danger of throwing the proverbial baby out with the bathwater.

Investor psychology

There are many ways to describe the investor psyche, but two words very much sum this up, fear and greed. First, the fear of being out of a particular stock when the rest of the market seems to be buying can be dangerous. Then we have greed, those who look to squeeze the last penny out of their investments. In the words of Lord Rothschild, "The reason I am so rich is because I always sold too early". Let's put this into perspective.

Once a share price hits a short-term peak, and the sellers begin to emerge, the trend can quickly reverse. When it does change, you may struggle to sell stock in decent size, potentially leaving an open position which is falling in value. There is a similar scenario on the downside, with sellers being drawn in on the way down while buyers wait for the "bottom". You are unlikely to sell at the top or buy at the bottom of any market. Hence, Lord Rothschild was so wealthy - he left a “bit” for the next investor.

Summary

Whether you are buying, selling or inactive during volatile markets, you must keep a clear head. While there may be times that you need to take into account extreme short-term market volatility, fundamentals are always the key. Many of the behavioural tips and investment ideas mentioned above may prove beneficial in the future. If they prompt you to at least consider the options that is a success. You should also constantly ask yourself one simple question, would I buy this investment today?

Unfortunately, many overlook the benefits of a healthy mental and physical state. If you think of your brain as the engine and your lifestyle as the food, you get out what you put in. A fast-moving and relatively unhealthy lifestyle will not help your brainpower. Whereas those who eat healthy, exercise and socialise, with the ability to switch off from investment markets from time to time, are likely to be more balanced. 

We know that stress is a potential killer, but it can also decimate your investment strategy, prompting you to carry out transactions you immediately regret. Surely it is easier to look at the fundamentals and ignore any unhelpful noise? Think twice, execute once……..

Get in touch with Scott Kingsley

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Sources:

Six tips for better behavioural investing

Five behavioural tips for investors to deal with volatile markets

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